Industrial the new black, but be mindful of the grey: Richard Stacker

‘Industrial is the new black’ has been bandied around the property sector over the past 12 months, but the catch-phrase itself and the notion that all industrial assets will outperform over coming years may prove overly simplistic.  

The drivers behind the renewed push of the industry toward industrial assets are clearly apparent; with the near record spread between industrial yields and debt costs and returns on fixed interest assets, such as term deposits, making returns highly attractive. 

Add to this a market where investment demand is above trend and supply levels below long-run averages, and industrial is a standout in the current environment.  

Certainly, this is an opinion shared by Charter Hall, and our overall weighting to the sector has been actively increased over recent years with the launch of our $500m Core Logistics Partnership (CLP) and Core Plus Industrial Fund (CPIF) having capacity to grow to $900m when fully invested. 

On the direct side, we closed the $208m Direct Industrial Fund (DIF1) portfolio oversubscribed and are now well advanced on raising $120m of equity required for the Direct Industrial Fund No. 2 (DIF2).  

But despite these broad positives, the need to remain selective on asset purchases is paramount, with tenant quality, building design, and lease covenant the absolute priority. We are mandated to only acquire exceptionally secure assets with lease terms in excess of 10 years to investment-rated tenants.

 Secondary assets may provide yields that look compelling, but with shorter lease terms or inferior covenants, we must strongly consider the downside and be priced accordingly.  

Do we pay more for prime assets? Absolutely. But with debt costs now under 5% for such assets, the accretion on a yield of circa 7.5%-8% is extremely compelling, when returns on 3 year term deposits have fallen 220 basis points in the past three years and now yield approximately 4.3%.  

While initial yields for secondary stock are very attractive at upward of 8.5%, this often comes with substantially higher risk. A recent survey by Knight Frank of the east coast industrial market showed there is over 971,000 square metres of secondary industrial space vacant.

 This is around 37% more than the prime stock for lease.  When considering that the vast majority of major leasing activity is occurring in the prime grades, the challenging secondary market becomes evident.  

Development in the industrial sector is relatively low by historic standards. That said, we have seen a rise of 8.9% over the past year as tenants look to upgrade space and developers and financiers become increasingly confident in speculative development.  

Uncommitted new supply is particularly apparent in Sydney and Melbourne, with just under 250,000 square metres of stock being under construction without a precommitted tenant.  This may see secondary assets face increasing competition in years to come, and investors should make adequate assumptions for any potential periods without income – and how this may impact capital values.  

The latest IPD results showed the industrial sector provided a healthy unlevered total return of 9.3% over the year to June 30, but unlisted industrial syndicates (where Charter Hall’s DIF fund represents 54% of the index) outperformed all other classes returning a substantially stronger 12.5% as high occupancy and fixed income growth lead to strong performance.  

Overall in the current low interest rate / lower growth environment, the new black for property is secure assets with fixed growth, low capital expenditure requirements and strong covenants that carry minimal income risk.  While this style of asset may be more prevalent in industrial due to the leasing structures, investors should look beyond a simple allocation to the sector.

Richard Stacker is head of Charter Hall Direct Property.

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